Bengaluru: Non-banking financial companies (NBFCs) and private equity (PE) funds are lending to real estate developers at a frenetic pace, with refinancing of loans making up a bulk of such transactions, as the property market remains in the grip of a slowdown and project cash flows stay uncertain.

Property sales have remained muted for nearly two years now, with the national capital region (NCR) and Mumbai still not showing signs of a pickup anytime soon, but that hasn’t deterred NBFCs and PE investors from funding realty firms.

Analysts and domestic investors are worried that if sales don’t pick up in the next 6-9 months and the much-awaited cash flows don’t come in, it may get increasingly difficult for developers to repay these loans, resulting in delays and defaults.

“Around 65-70% of domestic investments in real estate, both from NBFCs and private equity funds, are mainly refinancing transactions today. In a debt-centric market, investors have given money in anticipation that sales will return,” said Shashank Jain, partner, transaction services, PricewaterhouseCoopers India.

Loans over the past two to three years, too, were based on the premise that the sector will revive soon, but their tenure is coming to an end now, said Jain.

Real estate needs capital to replace earlier debt as investors press for exits. They also need money for last-leg financing to complete projects as start-up capital to kickstart projects and to acquire distressed assets.

Unlike the slowdown of 2008-09 when liquidity was a serious concern, developers have better access to capital now. With so much capital, developers’ borrowing costs have come down, pushing them to raise more money as they wait for sales to recover.

With competition between NBFCs and PE funds getting aggressive, some PE funds are slowing down capital deployment, weighing in on the high risks involved in lending to the sector.

“The NCD (non-convertible debenture) market is crowded and moving to a zone where risks are high. Lending rates are coming down and investors are taking up too much risk for a project, where the loan-to-value ratios are crazy, which are based on assumptions of sales,” said S. Sriniwasan, chief executive officer, Kotak Realty Fund.

He said, “There is no compulsion to do deals, and we are being selective and deploying slowly, and drawing capital from investors only when we see a good deal.”

Between January and March this year, PE investments in real estate jumped to $527 million, compared with $100 million in the first three months of 2014, according to VCCEdge, which tracks investments. 2014 saw a total of $2.264 billion of PE lending to the sector.

Most domestic investors follow the NCD route, a popular debt instrument which typically cannot be converted to stock and offers yields of 14-20%.

“We are a bit more cautious as a fund, and evaluate deals more conservatively. There is a bit of a churn happening in the real estate sector, with a few developers doing joint development deals, and some who are exploring exit options from projects,” said Rahul Rai, head of the real estate investment business at ICICI Prudential Asset Management Co. Ltd. In refinancing deals, ICICI Prudential prefers developers with projects that have an established location or have seen partial sales, Rai said.

Refinancing transactions are not new, but only in recent months have they started to dominate the real estate scene.

In one of the largest single project transactions in recent times, Omkar Realtors and Developers Pvt. Ltd raised `1,200 crore from Piramal Fund Management Pvt. Ltd as project-specific debt for a luxury residential development in Mumbai.

The transaction was structured in such a way that `400 crore would be used to refinance Omkar’s existing debt and the remaining `800 crore would be secured against a so-called 20:80 scheme and is intended to be drawn on as construction progresses over the next two years. The 20:80 scheme lets a customer make 20% payment upfront and the rest only on possession of the home.

“Omkar refinances debt so it can replace high-cost debt with lower-cost debt. Going forward, it plans to do a couple more refinancing transactions for the same reason,” said a person familiar with the development, who didn’t wish to be named.

“If we underwrite refinancing risk, it must be on the basis that the underlying project will start generating cash flows that are sufficient for a full repayment of the current round of financing; that is, we are not expecting another refinance a few years down the line in order to provide an exit for our capital,” said Khushru Jijina, managing director, Piramal Fund Management.

However, if the underlying project status suggests that a delay in sanctions or approvals is endemic or that the sales figures are “creatively” reported and there is a strong risk of cancellation of existing sales, then Piramal would be concerned, added Jijina.

As assets become distressed and other special situations arise in the sector, investors are not hesitant to step in, of course, by claiming a higher stake and significant collateral, said analysts.

Karthik Athreya, managing director and chief executive, Altico Capital India Pvt. Ltd, an NBFC, said that there is significant unmet demand for alternative capital in India to fund special situations, which on the one hand have slower-than-anticipated corporate recoveries and balance sheet issues, and on the other, present growth opportunities in an improving economy.

Altico has raised substantial dedicated capital to follow a credit strategy wherein it refinances existing loans, provides last-mile financing to complete stuck projects and taps growth opportunities that banks are unable to lend to by way of senior and mezzanine credit structures secured by real estate projects and assets, said Athreya.